Economic Notes: August 25, 2014

August

25

Economic data points from the week were quite good, and showed a continued rebound of conditions. Inflation, as measured by CPI at least, rose at a tempered pace we’ve come to expect.

Equities and other risk assets were higher, with positive data economic data noted above and lack of geopolitical disruptions; bonds sagged on higher interest rates as a result of the same.

(0) The consumer price index for July, on both a headline and core level, came in +0.1% higher (the former was in line with expectations, while the core side—sans food and energy—was half the change expected). On a year-over-year basis, the headline and core rose +2.0% and +1.9%, respectively, so minimal differences net-net. During the month, a tempering in airline ticket prices was the odd contributor, although a change in how those prices are accounted for explained a bit of this. The shelter components rose in the range of +0.2-0.3%, which was a bit higher than in recent months. Food price increases along the magnitude of +0.4% were tempered by a -0.3% decrease in energy, which explains the similarity of the headline/core numbers. Overall, these tempered inflation increases are on par with recent trend, and fall just under the Fed’s stated target.

(+) The Philly Fed survey, like the neighboring NY Empire survey the previous week, showed strength for August, coming in at +28.0, surpassing forecasts calling for +19.7, but were 4 points weaker than last month’s acceleration pace. Accordingly, several underlying metrics were noticeably weaker, such as new orders, shipments and employment.

(+) The NAHB housing market index for August gained more than expected, moving up 2 points from last month to 55 (expectations had been set at the prior month’s 53). All three segments—present single-family, future single-family and prospective buyer traffic—increased at roughly the same magnitude. The Midwest was the best-performing region, while the South and West declined. Improvements are welcome in housing, which has been a lagging area in this phase of the recovery, but the level continues to remain below the recovery high (58) last summer.

(+) Existing home sales for July rose +2.4%, which was a positive surprise compared to the expected decline of a half-percent, bringing the sales level to 5.15 mil. Those for single-family rose +3%, while condos/co-ops were generally unchanged. The months’ supply of inventory remained flat at 5.5. In keeping with trend, the ratio of distressed home sales to total sales moved down under 10%, compared to 15% last year; so investor speculation appears to have become a steadily less important part of the sales picture. Despite overall sales being down a bit from last year, the lessened speculative participation may point to the owner-occupier element being a bit stronger.

(+) Housing starts for July rose +15.7% to 1,093k units, which was a significantly better report than expected (consensus called for a +8.1% increase). Single-family starts rose +8%, while the more volatile multi-family rose +29%. Building permits also rose strongly, by +8.1%, compared to an expected +2.8%. Here also, gains were driven by multi-family, up +20%, while single-family rose just under +1%. A decent month, but overall start and permit levels remain far below a typical expected level, so there is some catching up to do from not only an economic cycle vantage point but also to keep up with demographic demand.

(+) The Conference Board’s index of leading economic indicators showed a sharp gain of +0.9% in July, which was an improvement by a few tenths over gains in May and June. The increase was led by yield spread conditions, building permits, initial claims and the ISM new orders report. The coincident and lagging indicators also rose for the month, both by +0.2%, which was at a slower rate than the prior few months—leading elements were payrolls, employment duration, and stronger lending, while slightly higher inflation was a bit of a headwind in hindsight. All-in-all, these indicators continue to point to recovery and improvement at a glance (and correlations to prior cycles), although the various components consist of data points we already know.

(+) Initial jobless claims for the Aug. 16 ending week fell again to 298k, below expectations of 303k. Continuing claims for the Aug. 9 week also fell, to 2,500k, which was lower than the anticipated 2,520k, and a new recovery low. No special factors or state estimates affected the results, per the Department of Labor.

(0) The FOMC minutes are obviously published long after the meeting ends, but offer some bits of clarification behind the scenes. The July notes reference a labor market that has improved faster than some committee members have expected; consequently, the exit-from-stimulus strategy was discussed at length. Recent improvement will likely challenge the need for such dovish/stimulative language as time goes on, assuming conditions continue to show repair and improve to a level considered more ‘normal’ compared to past cycles and potential. In fact, internal committee debate appears to reflect this transition.

In a similar vein was the annual Jackson Hole Fed symposium, hosted by the Kansas City Fed. In keeping with past conferences, the matters discussed are ones of current interest and/or geared toward the Fed’s leadership at the time. In this case, the title of ‘Re-evaluating Labor Market Dynamics’ is a nod to both aims, and implies the ongoing debate about ‘cyclical’ versus ‘structural’ unemployment (Yellen’s keynote speech diplomatically acknowledged both as factors). We’ve delved into this in past weekly reviews, but the Fed finds itself increasingly having to explain itself, as headline labor figures such as the unemployment rate and jobless claims have dramatically improved; at the same time, underlying issues such as labor force participation/demographics, quality of labor (mismatch between types of jobs needed and ability of workers to fill these jobs) and mobility due to peripheral issues (such as the ability to sell a home above water in a given location to allow for a job-related move) all remain areas of concern for the committee and political administration. Yellen is using a ‘dashboard’ approach to the employment debate (using over a dozen metrics), with the likely most important being items such as U-3 unemployment, U-6 underemployment, participation gap, annual wage growth, payrolls, JOLTs job openings, hiring rate and quit rate. It’s interesting to note that three-quarters of that list currently show less-than-desired readings, accounting for the philosophical discussions about the quality of labor market improvement. The Fed’s unique dual mandate has pushed labor issues into the forefront, and policies to provide a boost here may run counter to their other primary mandate of monetary/inflation stability.

Market Notes

U.S. stocks experienced another positive week, with U.S. large outperforming other segments and foreign equity. From a sector standpoint, financials and industrials outperformed while telecom and energy lagged with the weakest, yet still positive, returns.

Outside the U.S., returns were led by the larger emerging markets, with Russia, Brazil and India all gaining upwards of +2%. Japanese and Chinese stocks were two of the rare losing regions on the week. There certainly appears to be a shift towards higher levels of comfort in emerging markets, as economic conditions may have bottomed, while concern has risen in developed Europe due to lack of growth influences—recent returns reflect this evolution.

Bonds sold off on the week, with yields backing up from lows the prior week on stronger economic news and perhaps perceptions of the Fed minutes pointing to hawkishness. As expected, longer duration/low coupon debt such as Treasuries felt the bulk of the pain, while shorter duration and floating rate debt experienced the largest boost. Year-to-date, long Treasuries remain in the lead, but the majority of bond groups are in the positive. The dollar strengthened by a percent or so, but foreign debt performed well on the week despite the headwind—especially European bonds—as lackluster economic data pointed to additional accommodative measures.

Real estate segments were generally higher, but by a smaller margin than broad equities. Asian REITs bucked the equity trend in that region, gaining over a percent, followed by U.S. retail and residential, while European REITs lost ground—not surprising due to economy-related demand concerns. Homebuilding stocks, technically part of the consumer discretionary group and not real estate, but often thought of in the same vein, gained almost +5% in line with stronger housing numbers reported earlier.

Commodities were led by strength in industrial metals (copper and aluminum) and corresponding weakness in precious metals, as a ‘risk-on’ appetite in other asset classes flowed through to economically-sensitive contracts. Energy and broader agriculture were less affected during the week, although the WTI Crude contract fell from over $97 to just over $93/barrel, the lowest point since January.

Interestingly and maybe not surprisingly, mutual fund flows appear to have neutralized between stocks and bonds again. Investors seem uncertain about where to turn, and surveys of investor sentiment seem to confirm this. Questions overheard from investors lately include some of these conflicts. The economy seems to be getting better, so should I invest in stocks? Or, since stocks have run up dramatically from where they were in 2008-09, am I too late? Bond rates sure seem low but what if the economy falls apart again? We’re sure you’ve overheard similar sentiments. True, decisions aren’t as easy these days with valuations not bargain-basement levels, but that reflects the increasingly ‘normal’ non-crisis environment. If folks were much more confident and even exuberant about risk assets, we’d be much more concerned about where we are in the cycle. But, that skepticism coupled with positive plod-along growth could offer markets more time than seems to be currently feared.